The FINANCIAL -- About 9 months ago, we were already discussing the oddities of egg prices in Georgia (“The Georgian Egg of Discord”, by Giorgi Kelbakiani and Eric Livny, to be found on the ISET Economist Blog). At that time, a huge volatility in the egg prices could be explained by interesting political dynamics. Under the UNM government, local producers of eggs were largely protected from external competition through non-tariff import barriers, called by the ministry of agriculture a “complete violation of law and international agreements”. However, through these measures, a relative stability of egg supply (and thus prices) in the Georgian market was achieved, though at a relatively high price level (see the chart).
The new government removed these barriers, leading to soaring egg imports, going up from 1.5 million eggs in the last quarter of 2012 to 10.8 million eggs in the second quarter of 2013. These myriads of eggs spilling over the border caused prices to plummet, bringing many domestic producers to the verge of bankruptcy. Under pressure of lobbying efforts of domestic producers, the government reversed its policy and re-introduced non-tariff measures. Imports went down to 2.6 million eggs in the third quarter, but – and this was unexpected – also the Georgian production decreased by 20%! In the article of December, it was speculated that the new non-tariff measures hit importers and local producers alike, which is a possible explanation. As the new government wanted to keep to WTO regulations, it could not impose restrictions that exclusively apply to importers. But then, discouraging imports through all kinds of “quality” requirements (the natural thing to do with a high risk food as eggs), may turn into a headache also for local producers. Apparently, the old government resorted to some tricks in its policy to treat domestic producers preferentially, and that’s why it was accused of acting illegally by the new government.
However, other factors may have contributed to the decline in local production. Egg production is not very flexible. Once a production facility is established, the hens lay eggs and lay eggs and lay eggs, completely independent of price movements, demand and supply, and import regulations. Thus, lacking alternatives, producers may have reacted to the low prices in the first and second quarters of 2013 by reducing their capacities, which may still have been felt in the third quarter, even if the import restrictions had been reinstated at that time. As a result of all this, prices soared.
But the story continues…
The chart reveals that just a few months ago, we saw another dramatic fall in egg prices, dwarfing the price decrease of May 2013 which at that time caused the outcry of Georgian producers. Like in 2013, the recent decline of egg prices was paralleled by a huge increase of imports, yet this year it was even more impressive than in 2013. As there were no changes in import regulations, it seems as if we have to search for reasons not within Georgia, but outside its borders.
The first thing to note is that the regulations introduced in 2013 seem to have lost its effectiveness in protecting the Georgian market. This is not surprising, as Georgia did not reinvent the wheel when imposing its non-tariff restrictions. There is a tool box of measures you can apply when you want to make egg imports more difficult, and Georgia is not the first country in the world resorting to this tool box. Yet producers also know how to deal with these tools. It will take time and some additional costs, but a non-tariff measures that do not violate WTO regulations will sooner or later lose its effect, once the importers have adjusted.
The second illuminating observation about the graph is that egg imports reacted very swiftly to the decrease of egg prices in Georgia that happened in May. In July, there were almost no egg imports anymore. This indicates the prevalence of a certain market structure, which can be observed for many agricultural goods. One might assume that producers, say, in Turkey, set up egg production capacities targeted at a particular market, e.g. Georgia, and envision a long run flow of eggs from Turkey to Georgia. Yet this is not how it works.
For many agricultural goods the “world market” does not really encompass the whole world, as major consumers (in particular the US and the European Union) have their agricultural markets hermetically sealed and excessively regulated. Thus, price differences even for virtually homogenous goods (e.g. bananas from South America and bananas from Spain) do no disappear throughout the world, and there is not really a “world market price”. This does not mean, however, that a company which wants to import bananas to say, Europe, and which has the expertise to overcome the complicated regulations and deal with the bureaucracy, cannot find somebody to deliver the bananas. There are countries, in particular in South America, producing huge amounts of bananas completely irrespective of domestic demand and selling them to whoever offers the highest price. These “dollar bananas” flow into a country immediately when the internal price adjusted for transport and regulations costs is higher than what is paid elsewhere, and this influx stops abruptly when the internal price goes below that threshold. Yet while this market structure was first established for relatively durable agricultural goods, like bananas and grain, with the improved refrigeration and transport possibilities available today there are also “dollar eggs”, “dollar meat”, and there is “dollar milk”. What can be seen in the graph in April 2014 is a typical influx of dollar eggs into the Georgian market. With May prices of around 30 tetri per egg, the cloud of dollar eggs that is out there moved towards Georgia, and when prices fell, it equally quickly disappeared.
In principle, dollar eggs should lead to a complete equalization of internal prices and dollar egg prices (adjusted for transport and bureaucracy costs). Hence, we should not see this high amplitude of Georgian egg prices (which cannot be explained through movements in dollar egg prices, as otherwise the imports would not have declined that extremely). So, what has happened in the mysterious Georgian egg market in April and May 2014?
In Europe, Christmas is celebrated on the 25th of December, and in Georgia it takes place in January. For your January Christmas celebration, you want to have Christmas sweets for just a fraction of the price usually charged? Here’s the trick: Travel to Europe on December 27th and go to a supermarket. You will get chocolate Santa Clauses, Christmas cookies, and lebkuchen for about a third of the price they had before, i.e. roughly for wholesale prices. So, did the sellers of Christmas sweets order too much of that stuff? No, their behavior is rational, because the price premium sellers get for Christmas sweets before the celebration is so high that the worst thing that could happen to them is a shortage of chocolate Santa Clauses before the celebration. Therefore, their orders include safety margins, accepting that the excess orders have to be sold off with no profit after the holidays have passed.
In Orthodox Christianity, Easter is the highest holiday, and eggs are the most important dish associated with Easter. Like the European sweets sellers, also Georgian egg sellers wanted to avoid a shortage of eggs during this celebration at all cost and included a safety margin in their calculations.
Unfortunately, with the availability of dollar eggs, this model does not work anymore. In Europe, there are no “dollar Santa clauses”, meaning that the producers of chocolate Santa Clauses have some price setting discretion. They can raise the price without millions of foreign chocolate Santa Clauses immediately coming over the border. Moreover, Christmas Sweets are not as homogeneous as eggs, and there are well-established brands like Lindt from Switzerland, further increasing the price setting power.
Yet in Georgia, as can be seen in the chart, Georgian sellers could not raise their prices at all despite the increased demand over Easter in April 2014, because all of this extra demand was satisfied by dollar eggs. The unprofitable part, however, namely selling off the excess eggs after Easter, happened nevertheless, bringing egg prices in May to abysmal levels. What was a profitable business model in the sealed market under Saakashvili, namely charging higher prices before and over Easter and afterwards selling off what remains (see the year 2012 in the chart, where prices peaked before Easter), does not work anymore when the market is open to dollar eggs.
Georgian egg sellers and producers have to understand this new situation and adjust their market behavior. Yet the party is over in any case: in a market open to dollar eggs, being an egg producer is a much tougher task than in an encapsulated Saakashvilian egg market. According to the Georgian Poultry Association, in the last five years the number of eggs producers in Georgia more than doubled from 12 to 30. Unless Georgia becomes tricky with its import regulations again, we can expect this number to fall.